The increased use of credit lines by private equity managers is making life harder for the limited partners and consultants that track the managers.
Sources said drawing out these lines of credit for longer periods and increasing the value of loans is bolstering internal rates of return by about 200 basis points, and more than 300 basis points in some cases. It means some managers are surpassing their carry hurdles, but the distortions are forcing consultants to look to other metrics in assessing firms.
David Fann, New York-based president and CEO of private equity consulting firm TorreyCove Capital Partners LLC, said executives at his firm have always used different analytical tools, but the "usage of these (financing lines has) made it difficult for a simple, straightforward apples-to-apples comparison of managers based on investment returns. Firms use these lines differently and some don't use them at all ... now, stripping out the effects of subscription lines is critical to manager assessment and benchmarking. Deconstructing investment performance is now more necessary than ever."
Andrew Brown, head of private equity manager research at Willis Towers Watson PLC in London, added: "Going forward we will benchmark IRR, but will definitely focus more on the multiples as a benchmark, with the IRR being less relevant. Some managers will use fund facilities for distributions too, so I think IRR as a benchmark ... goes out the window for less mature funds."
This "fund-level financial engineering" is a serious consideration for Cambridge Associates LLC, added Andrea Auerbach, a managing director and head of global private investment research in Menlo Park, Calif. "When our clients invest or we invest in a fund, we're not hiring the manager to employ fund-level financial engineering for the return, but to buy companies, improve their value and sell them at a gain. This level of noise at the top can obscure the true core talent of the manager because the underlying activity is masked."
But there are ways to "pierce through that fog," she said, citing guidelines from the Institutional Limited Partners Association, which include that GPs should publish returns on a leveraged and unleveraged basis.
ILPA's guidelines also were highlighted by Victor Quiroga, founding partner at Triago in New York. "They have really helped by creating a baseline for acceptable use of subscription lines. A significant departure from that baseline is what people are concerned about," he said.